Euro Stymied By Softer IFO

The IFO survey reading of business climate slipped a bit from last months record of 108.7 to 107.9 as companies in Germany expressed concern over the increase in the value added tax from 16% to 19%. Current conditions also retreated to 112.8 from 115.3 but the expectations index remained upbeat climbing to 103.3 from 102.5 suggesting that most businesses feel the fallout from the tax hike will be temporary.

VAT related worries also weighed on consumer sentiment earlier in the night when the GFK Consumer survey dropped sharply from 8.7 to 4.8. It remains much too early to gauge the impact of a near 19% increase in value added taxes on the region’s largest economy, but certainly both consumers and producers are approaching the event with trepidation. The issue could become a huge albatross for the Merkel administration if it suddenly chills economic activity in Germany just as the country is finally generating some growth momentum. However, the key determinant of success or failure may lie outside the reach of either businesspeople or politicians. If the price of oil remains below $60/bbl providing a benign environment for EZ consumers, the increase in VAT taxes may indeed be absorbed with minimal pain. If on the other hand, oil begins to rally in the summer season, the double whammy of higher taxes and higher energy costs will almost certainly stifle any recovery in EZ consumer demand. For now the currency market has shrugged off the news believing that it will have only a small negative effect on growth and will not prevent the ECB from hiking rates further. But if the retail data from the region begins to shows signs of additional deterioration, traders will have to reassess their nonchalant attitude and consider seriously the possibility of a nasty slowdown in the Euro-zone as a result of these policy choices.

In Asia tonight, carry trade continued albeit in a herky-jerky fashion as yen see sawed against the dollar and on the crosses after BoJ member Suda noted that the central bank ran the danger of acting too late on the issue of rate hikes if it waited for complete confirmation from economic data. She stated that Japanese consumption will rise gradually in line with wages and noted that recent slump in spending was a one off effect of bad weather. The yen sold off in response to her comments but was unable to penetrate the critical 120 level. Nevertheless, with market psychology now having shifted to carry trade liquidation, tomorrow’s Japanese CPI release could be the spark for further selling if it meets or beats estimates and 120.00 could easily give way in a torrent of stop triggered selling.


Kathy Lien is the Chief Currency Strategist at

Forex Capital Markets. Kathy is responsible for providing research and analysis
DailyFX, including technical and fundamental research reports, market
commentaries and trading strategies. A seasoned FX analyst and trader, prior to
joining FXCM, Kathy was an Associate at JPMorgan Chase where she worked in Cross
Markets and Foreign Exchange Trading.